How Peer-to-Peer Insurance Works

Photo: Shutterstock/Roman Samborskyi

Collaborative or peer-to-peer (P2P) insurance is a relatively new insurance model that combines the latest technology and the sharing economy with the principles of mutuality that are at the roots of the insurance industry. Instead of a traditional insurance company, groups of participants in P2P insurance pool their funds to protect against similar risks.

This was the topic of an article that the editorial board of the Society of Actuaries’ (SOA’s) North American Actuarial Journal (NAAJ) chose as the best paper published in 2022. Since 1983, the NAAJ editorial board has selected a single stand-out paper from the journal each year. In the 2022 winner, “Collaborative Insurance with Stop-Loss Protection and Team Partitioning, ” authors Michel Denuit, Ph.D., professor of actuarial science at Université Catholique de Louvain, Belgium, and scientific and innovation adviser at Detralytics, a Belgian-French actuarial consulting firm, and Christian Y. Robert, Ph.D., professor of actuarial statistics and mathematics at Institut de Science Financiére et d’Assurances, Lyon, France, and Detralytics scientific director, designed a flexible P2P system that offers relatively attractive entry prices and potential cashback along with stop-loss protection.

The Growth of Peer-to-Peer Insurance

P2P insurance presents a solution to a growing conundrum the insurance industry faces: How to offer appropriate coverage to every customer that meets their expectations.

Younger consumers are questioning existing models, including traditional insurance. At the same time, new technologies encourage the creation of prosumers—individuals who both consume and produce. A local energy community that provides electricity members produce via solar panels or windmills is an example of a prosumer market, and it also provides an analogy to P2P insurance communities.

“The peer-to-peer insurance offer has developed in line with the sharing economy and has been made possible by the advent of internet platforms,” said Denuit. “To reduce expenses, new technologies are used to build risk-sharing networks where groups of individuals pool their resources to insure against a given peril.”

Protection from Catastrophic Loss and Fair Risk Pooling

The award-winning paper designs a new generation of P2P property and casualty insurance policies in which a community shares the lower layer of risk and a traditional insurer covers the higher losses. While pure P2P insurance does not include guarantees, the collaborative insurance designed in this paper supplements risk sharing with risk transfer to stop-loss protection provided by a reinsurer.

The paper also proposes grouping participants into teams based on existing networks, such as families or those with common economic interests or regional locations. It then adapts the system to account for two levels: individual and intermediate community levels.

“We structure the risk-sharing network into groups made up of individuals who are friends, family members or have similar interests and risks, like members of the same profession or patients suffering from the same disease. We then demonstrate how to share surpluses between and within teams in a fair way,” said Robert.

The intermediate community level retains the lower risk layer, which can be experienced as a deductible shared among the individuals who make up the community. In contrast, the upper layer is transferred to the (re)insurer. Sharing the first risk layer among policyholders is an effective way to access the best of two worlds: protection via equity capital for the higher layer of risk and mutually shared risk for the lower layer.

Furthermore, because insurance risks can vary among participants, equally sharing total losses may seem unfair. So, the paper’s authors set out to limit participants’ contributions to an upfront payment in proportion to their relative risk. Then, in the case of a favorable experience, cashbacks are distributed to restore fairness.

Finally, to provide transparency, the paper suggests the regular dissemination of reports that disclose meaningful metrics and an annual summary that describes loss experience over the period, indicating the amount of risk sharing and risk transfer for each participant.

The Actuarial Role in Developing Peer-to-Peer Insurance

The paper attempts to show that proper actuarial modeling for P2P insurance is available. Actuaries open to new insurance paradigms and actuarial science instructors may be interested in this award-winning paper. It demonstrates that it is possible for a P2P insurance offering to evolve within the insurance industry.

“The actuarial model we propose for peer-to-peer insurance provides the missing link between the homogeneous case where total losses are equally shared among participants and pooling benefits are clear from the law of large numbers and central limit theorem,” said Denuit, “and the heterogeneous case where each participant assumes a share of total losses aligned to their risk profile.”

Actuaries are crucial in the development of the promising insurance products that emerge from digital platforms. New tools and techniques are key to their effectiveness. Learn more about new P2P insurance models in the prize-winning NAAJ article, “Collaborative Insurance with Stop-Loss Protection and Team Partitioning.”

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